Selling the Right to PollutePosted: May 6, 2009
I decided I need a break from the finance side of the economy for awhile and start a discussion on the Obama Administration’s Cap and Trade initiative. This is an extremely controversial plan and will basically cause political alignments of states and regions more than party affiliation. Cap and Trade programs have been discussed in economic circles for some time but have never been seriously considered anywhere but Europe, so let’s start with the basics of what may be an unfamiliar topic. Several years ago, I was asked to sign my name to a list of economists supporting the initiative. In the interest of open discussion, I’ll let you know that I passed on request.
Cap and Trade Systems are also known as emissions trading or more traditionally, allowance trading. The idea is that a company recieves an “allowance” to release a particular pollutant into the environment. It can either hold the allowance and release the pollutant, sell the allowance and give up any right to release the pollutant, or buy others’ allowances and receive a higher allowance to release the pollutant. In other words, the allowance would be a marketable asset that would be priced in a market. This makes the approach “market-based’.
The goal of a Cap and Trade System is to steadily reduce the emission of the pollutant. Int the case of the Obama Administration’s initiative, the pollutants are carbon dioxide and other greenhouse gas emissions. Initially, some one has to decide the initial acceptable ‘allowance’. This basically establishes the ‘cap’. Here’s the description of the ‘cap’ given by the Center for American Progress.
Each large-scale emitter, or company, will have a limit on the amount of greenhouse gas that it can emit. The firm must have an “emissions permit” for every ton of carbon dioxide it releases into the atmosphere. These permits set an enforceable limit, or cap, on the amount of greenhouse gas pollution that the company is allowed to emit. Over time, the limits become stricter, allowing less and less pollution, until the ultimate reduction goal is met. This is similar to the cap and trade program enacted by the Clean Air Act of 1990, which reduced the sulfur emissions that cause acid rain, and it met the goals at a much lower cost than industry or government predicted.
So, here’s the first practical question for implementation purposes. While the government will set the cap, who gets to decide the level of the cap? Will there be input by industry? politicians? EPA? environmentalists? Which voices will be given the most say?
So, once the cap is established as an allowance. The allowance becomes something akin to a permit that one can sell or buy. The regulator (presumably the EPA) then checks the amount of the emissions made by the industry or the company of the year. That polluter must then hold an adequate balance in their allowance to cover the emissions. Total emissions must stay within the cap.
So, now we arrive at the next question on implementation. What happens when a polluter exceeds the cap? How flexible is the fine or punishment? What exactly is the punishment? Who sets the level of the fine or punishment?
The rational behind the market trading is that for some industries, it will be easier to lower their polluting, thus giving them the ability to profit from selling their allowances. Other industries will find it difficult to meet the cap so they will be forced to go to the market to buy additional permits. Then the supply and demand forces take over. If every one wants to pollute and needs more permits, the price of the permits will go up. At some point, the price of the permit will be as prohibitive as the cost of lowering emissions, so the company will then choose to lower its emissions. This should eventually lead to lower overall emissions in the country. This should essentially reward the clean industries and punish the dirty ones.
This is what is leads to the controversy and the split in politicians along regions more than parties. Any politician in a state that relies heavily on coal or other high carbon emitting energy sources will be unwilling to punish their state’s economics mainstay. This leads me to another question. Will we see the system become complex to administer as politicians maneuver to find exemptions for their pet industries, much they way the maneuver now to find tax exemptions and credits? Tons of specific exemptions and credits will water down the result of the program as well as make it difficult and costly to administer for every one involved. This quote explains how both the government and certain industry could realize profits from the trade.
If the federal government auctions the emissions permits to the companies required to reduce their emissions, it would create a large and dependable revenue stream. These financial resources could be used to achieve critical public policy objectives related to climate change mitigation and economic development. The federal government can also choose to “grandfather” allowances to the polluting firms by handing them out free based on historic or projected emissions. This would give the most benefits to those companies with higher baseline emissions that have historically done the least to reduce their pollution.
We currently have a cap and trade system in place for Sulfer Dioxide emissions that are identified as the main culprit in damage from acid rain. Here’s some information on the status of this program that was implemented during the Clinton years from Grinning Planet.
Sulfur dioxide is one of the pollutants responsible for acid rain, which can damage forests and acidify lakes and streams, rendering some of them incapable of supporting aquatic life. SO2 air pollution also causes respiratory and other health problems in people.
A cap-and-trade system was imposed on sulfur dioxide emissions in the US in the mid-1990s. As of the end of 2002, the last reporting period available as of this writing, reduction of SO2 was ahead of schedule—down 41% from 1980—with the market price for emission allowances significantly lower than the dire predictions made by industry critics prior to the program’s implementation. As one can see from the EPA chart below, wet deposition of sulfur dioxide is much less today than it was in 1990. Overall airborne sulfate concentrations have decreased similarly.
Cap and Trade systems have also been proposed for Mercury which can cause severe health problems in people. Mercury levels in drinking water or seafood would be subject to allowances under this program. Evidence has show that Cap and Trade systems work best when:
- the effects are wide-ranging or global (as opposed to local or regional)
- there are a large number of emission points
- the cost of controls varies from source to source, thus providing the basis for a market to trade emission allowances
As previously mentioned, this policy faces major hurdles in congress. Truthout discusses some of those issues in Obama Could Create A Cap and Trade System Without Congress.
In a report released today, the Institute for Policy Integrity at New York University School of Law found that if push comes to shove, Obama could create a cap-and-trade system on his own, complete with auctions and the ability to sign an international agreement.
This means that if the Senate refuses to agree to meaningful action on climate change, there is another option available. Obviously this is not ideal – legislation would provide a better democratic “stamp” and help ensure the longevity of the policy. But at the end of the day, with climate tipping points breathing down our neck, and the Copenhagen summit looming large, it is good to know that our President could pull the trigger.
At the same time that the Obama administration has the option to create a cap-and-trade system, it is also under a strict timetable to begin regulating greenhouse gases from a host of sources. First cars, then marine vessels and aircraft, and eventually stationary sources. Many of these mandatory requirements of the Clean Air Act can only be fulfilled by command-and-control regulation – which businesses hate because they are more costly and constrain flexibility. By law, EPA will eventually have to choice but to regulate. If industry wants to avoid these regs, then, they will have to go through Congress.
As EPA moves closer to adopting greenhouse gas regulation, it will continue to turn up the heat on Congress. Industry will want to avoid costly regs, and the status quo for greens shifts from total inaction to regulation by EPA – giving them greater ability to say no to a bad deal.
As you know, I’ve always preferred the direct tax method. Carbon Taxes are an alternative. This article by the Christian Science Monitor brings ups some interesting issues in its article “Why cap and trade could backfire”.
Under cap-and-trade rules, the government places an artificial cap on the amount of carbon each regulated facility may emit. Facilities producing more carbon than they are allowed are required to purchase additional credits to make up the difference. The opportunity to purchase these credits creates a market where none previously existed.
As in the example of the fined parents, the purchase of the right to emit greenhouse gases would likely reduce any stigma associated with doing so. Emission levels, consequently, could rise.
This phenomenon is already seen on an individual level. Al Gore says the risk of catastrophic global warming is so great that Americans should act immediately to reduce greenhouse-gas emissions. Yet his home uses 20 times more energy than the average American home, according to the Tennessee Center for Policy Research. That’s OK, the former vice president assures us, because he purchases offsets to ensure that he lives a carbon-neutral lifestyle.
His message – albeit unintentional – is simple: Produce carbon to your heart’s content; just pay a carbon broker to “neutralize” your carbon footprint and your guilt.
This is why I have issues with such a system besides some of the other questions I introduced above. I don’t like the idea of neutralizing the stigma of pollution. It’s bad. It should be eliminated. There should be a definite punishment for doing it. Just tax it!
Hopefully, this will give you a few things to think about as the Obama initiative works its way through the legislative process. Again, it is possible that the EPA could initiate a system without congress. This has an entirely different set of implications. At least we’ve gone back to a conversation about pollution and global warming based on something other than denial and bad science.